Thursday, July 14, 2011

Nigeria: Islamic Banking - Issues and Challenges

The Central Bank of Nigeria (CBN) has gone a long way in laying the groundwork for the commencement of Islamic Banking in Nigeria. At a recent workshop in Bauchi State, the Special Adviser to the CBN governor on non-interest banking, Dr. Bashir Aliyu Umar, highlighted the issues and challenges of the project in his paper.


Islamic Finance is a financial system that is based on adherence to the Shariah or Islamic law. It offers services, products and instruments based on compliance to this Divine Law. Central to the precepts of the Shariah is that commercial and financial transactions must adhere to these prohibitive principles:

1. Prohibition of Riba, which is usury or interest. The Shariah, just like the teaching of the old testament, and the early position of the Christian Church as contained in the First Ecumenical Council of Nicea in 325 AD and the second and Third Lateran Councils (1139 and 1179 respectively), all prohibit the use of an association with interest...Former President (Olusegun) Obasanjo speaking in 2000 about Nigeria's mounting debt to international creditors said: "All that we have borrowed up to 1985 was around $5b, and we have about $16b. Yet we are still being told that we owe about $28b. That $28b came about because of the injustice in the foreign creditor's interest rates. If you ask me what the worst thing in the world is, I will say it is compound interest. Well, whether simple and compound interest, they are both evil.

2. Gharar is the next most important prohibition in Islamic transactions and contracts. Gharar means lack of certainty. Its prohibition stems from informational asymmetry and refers to any uncertainty created by the lack of information or control in a contract or its conditionality.

This includes want of knowledge over the subject of the contract, or the price to be paid - its nature, amount, or period of payment. It also includes cases where the subject of contracts is something over which neither party has control. Classic examples include transactions involving the sale of birds in flight or fish not yet caught or an unborn calf in the mother's womb, or a runaway animal.

More modern examples include transactions where the subject is not in the possession of one of the parties and there is uncertainty even about its future possession, as is the case with speculative contracts. This prohibition of Gharar is considered to be the prohibition of risk or the prohibition of derivative instruments in today's financial markets, which are designed to transfer risks from one party to the other. (Zamir Iqbal, Abbas Mirakhor: 2007).

3. Prohibition against gambling (maysir). Gambling represents an unproductive exchange of property, and in every transaction involving gambling one side wins and the other side loses. It is a clear case of squandering people's wealth unjustly, and its prohibition is unequivocal in the Qur'an and Sunnah (sayings, actions and approvals of the prophet of Islam, peace be on him), which are the two main sources of the Shariah.

4. Prohibition against the sale or purchase of unlawful goods and services. Examples include pork, alcohol, pornography, tobacco, narcotics and any item that is deemed harmful and unlawful according to the Shariah. This therefore imposes the need to screen all transactions and activities through moral and legal filters based on the Shariah, which is largely equivalent to the western concept of socially responsible or ethical investing. These prohibitions combined form the bed of Islamic finance.

As the alternative to interest-based lending, Islamic finance adopts asset-backed financing. This type of financing uses a number of instruments of finance. Among them are the following:

a. Musharakah which involves partner providing funds for a venture, with profits shared according to their invested capital, and the loss is borne by them in the same way;

b. Mudharabah financing is when one partner gives money and the other party provides his entrepreneurship to invest and manage the project. When a financier contributes money on the basis of the two instruments, the money is converted into assets having intrinsic utility. Profits are generated through the sale of these real assets, and all parties share in the risk and reward, as opposed to what obtains in interest-based financing, where the financier does not bear any risk of the venture or project, but gets his reward come what may;

c. Salam is another mode of financing in Islamic finance. It is a sale where the seller undertakes to supply some specific goods to the buyer at a future date that is specified in exchange of an advanced price fully paid at spot. This mode of financing is used to finance the agriculture sector;

d. Istisna' is another mode of financing where the commodity involved is manufactured to the specifications of the purchaser. This is widely used in the housing finance sector, where the client seeks finance for the construction of a house. The financier may undertake to construct the house on a specified land either belonging to the client or purchased by the financier, on the basis of istisna', with payment fixed in whatever manner the parties may wish.

e. Murabaha, though originally a particular type of sale and not a mode of financing, it is nevertheless used for financing subject to conditions. Murabaha is kind of sale where the seller expressly mentions the cost incurred by him of the commodity offered for sale, and sells it to another purchaser by adding some profit or make-up thereon. The payment can be on the spot or deferred or instalment. Murabaha as a mode of finance is used to finance raw materials, inventory, equipment, asset a mode of finance is used to finance raw materials, inventory, equipment, asset financing, import and export financing, consumer goods financing, even working capital financing. Furthermore, all services that can be sold in the form of a package, like education, medical, tour etc can be financed through Murabaha;

f. Ijarah is the hiring of the services of persons, or the transfer of the usufruct of a property in exchange for a rent. The second type of Ijarah is the one that is used as a mode of finance, though originally not being a mode of finance. It has many features similar to a financial lease. It has also been used as a basis for securitisation helping to create a secondary market for financiers.

All these modes of finance involve the transfer of assets and are not based on making money from money alone as is the case with interest-based transactions. From the Prohibition of dealing in unlawful goods and services and from the other Prohibitions, we can see that Islamic finance is an ethical finance and investments and activities are socially responsible.

Furthermore, Islamic Finance is a socially inclusive finance system, which is another point that makes this topic on Islamic finance very relevant to the theme of their worship, which is about financial inclusion. A primary determinant of soundness of finance system and its stability is the public trust and confidence in its institutions and markets.

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